TO: FROM: DATE: SUBJT: Professor Robert S. Hansen Abdullah Al-Gwaiz, Yun Yan, Chuanjie Lan, Minyuan Ma，and Avinav Sharma 09/09/2013 Assessment of Marriott’s Growth Strategy and Cost of Capital

In this memorandum we will first discuss the four strategies that Marriott has outlined to achieve its new goal of higher growth. Second, we evaluate the WACC approach that the Company uses to estimate its cost of capital, delineate how to apply the WACC method, and discuss its merits. The Company has outlined four strategies in order to achieve its growth objectives: Manage rather than own hotel assets The first strategy Marriott outlined is consistent with the Company’s objective of more growth. Managing, rather than owning hotels, will save more on capital for Marriott,and it will allow the Companyto invest in other profitable projects. Selling hotel assets will also pay for the high costs involved in building hotels in the short-term, such as construction costs and land purchases. Managing hotels will likely provide a consistent stream of income over time with relatively less risk. Moreover, this strategy also helps the Company share more of its risk with business partners. Invest in projects than increase shareholder value The second strategy may not be appropriate for the growth of the Company becausedebt forms a large percentage of Marriott’s capital structure.Focusing on increasing shareholder value can lead to larger agency problems between equity owners and bondholders, which increases costs for the Company. Therefore, only increasing shareholders’ value couldlower the value of Marriott, and it will work against achieving the goal of higher growth. Optimize the use of debt in the capital structure

Optimizing the debt-to-equity ratio is a condition for maximizing the value of the Company and minimizing the weighted average cost of capital (WACC). Thus, a lower WACC may facilitate the growth of the Company.Issuing debt also has the benefit of providing a tax-shield. However,the debt-taxshieldadds benefit only to an certain extent, after which it begins to decrease a company’s value. Other, non-debt-tax-shields can also decrease marginal benefit of more debt. Optimizing the level of debt, therefore, is crucial for prospects of growth and reduction of the cost of capital (WACCmin = Vmax). Repurchase undervalued shares Repurchasing shares may not be the optimal use of cash because of the opportunity cost involved. It may benefit the company, however, by putting upward pressure on the price of its shares, and therefore increasing its equity and firm value. The accuracy of the Company’s estimate of its share price is important for the strategy to be more effective. Estimating the cost of capital Marriott uses the WACC approach to estimate the cost of capital for the Company as whole and for each of its divisions. There are three inputs which Marriott uses: debt capacity, debt cost, and equity cost consistent with its level of debt. Since Marriott operates in three sectors, and given that each sector has a different sensitivity to changes in interest rates, the Company uses floating rate debt for a fraction of its debt level in each sector. In most cases, the WACC method is relatively accurate and provides reasonable estimatesof the discount rate. The calculated WACC for the whole Company is 9.82%. In estimatingthe WACC, we used the 30year interest rate onU.S. Treasury bondsas the long-term risk free rate, and the geometric average value of S&P from1926 to 1987 as the market return. The risk premium is equal to the market return minus longterm risk free rate. Since the WACC equation contains both equity and debt, we used theCapital Asset Pricing Model (CAPM)to calculate the cost of equity, and then added the debt premium to the long-term risk-free rate to get the cost of debt. Finally, we use target leverage of the whole company to get the WACC. In this calculation, we use the geometric average value because extreme…